Who Knew? On the Recovery Act, Keynes Had It Right All Along

August 19th, 2013 at 9:56 am

Back when we used to argue about the Keynesian stimulus known as the Recovery Act, I posted charts like those you see here: very simple pictures showing that real GDP started growing shortly after the Act’s implementation at the same time that job losses decelerated.

I’ll be the first to admit that there’s lots of moving parts to these economic relationships and that this is far from detailed statistical analysis, though such analysis has also found compelling evidence that the Recovery Act had its intended effect.

I now see that the Bureau of Economic Analysis has helpfully posted their own analysis of the Recovery Act on the national accounts, thus enabling me to do a little better than just drawing a vertical line through the GDP graph, e.g., when the Act became law (February, 2009). A nice thing about having the BEA time series is that you can get a feel for how key targets of the Act, like real GDP and jobs, responded as stimulus faded.

On that point, I’ve frequently opined that the problem with the Recovery Act was less that it wasn’t big enough and more that it faded too soon. The picture below arguably supports this view.

On the left axis, I’ve plotted the total impact on the deficit of all the different pieces of the Act, the state fiscal relief, safety net expansions, tax cuts, infrastructure, and so on (these are annualized quarterly data—if you add them up and divide by four, you get $787 bn, the cost of the stimulus). On the right, you’ve got annual real GDP and job growth.

When the stimulus was kicking in, adding significant demand to the economy, real GDP and job growth quickly turned less negative, with GDP turning positive later in 2009, and job growth beginning in early 2010. Moreover, as the stimulus flattened, so did they.

Like I said, this is simplistic analysis, but I’m shaving with Occam’s razor here: private demand fell off a cliff, a strong dose of Keynesian stimulus helped to reverse some of the damage, but when we pivoted away from stimulus and towards deficit reduction too soon—before the private sector was fully back up and running—that progress faded.

Sources: BEA, BLS

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3 comments in reply to "Who Knew? On the Recovery Act, Keynes Had It Right All Along"

An interesting take, but one I believe is incorrect, as an examination of the calendar would tend to disprove the contention. The Great Recession officially ended as of June 30, 2009. This implies that some momentum for growth had been started in the 2nd Quarter, before the Stimulus, passed in February 2009, could have had any effect.

The numbers for the 3rd quarter, July through September, reflected the beginnings of what could be characterized as a strong recovery. Again, before the Stimulus could have had any positive effect, if it were going to.

But in the 4th quarter, with the wasteful, ill-conceived and poorly implemented Stimulus in full effect, the momentum for growth had been overcome, and growth fell off to the dismal 1 – 2 % we are suffering from still. Subsequent analysis demonstrated that the Stimulus had a multiplier effect [velocity of money] of 0.6 to 0.8, when the minimum velocity of money in the private sector is 1.0 with the norm being greater than 2.0. In other words, the Stimulus actually was a drag on the economy.

The flaw in the argument for a positive effect of the Stimulus, and the $ 410 Billion increase in the FY 2009 Budget which thanks to base-line budgeting became $ 820+ Billion in FY 2010, is the inclusion of government spending in the GDP calculation. Artificially increasing GDP obscures the problems in the private sector, creating a ‘false positive’ that is unsustainable, as the economic burden of government is increased.

So Keynes was wrong from the get-go, and ill-advised Keynesian stimuli, couple with other bad government policies, have actually prevented a real recovery.

The argument that follows is persuasive:
Per Kent Crawford: “The flaw in the argument for a positive effect of the Stimulus, and the $ 410 Billion increase in the FY 2009 Budget which thanks to base-line budgeting became $ 820+ Billion in FY 2010, is the inclusion of government spending in the GDP calculation. Artificially increasing GDP obscures the problems in the private sector, creating a ‘false positive’ that is unsustainable, as the economic burden of government is increased.”

In addition, how long can the Federal Banking system pump money into the U.S. economy (money not from business productivity) before inflation caused by a lack of faith in the worth of the U.S. economy causes another economic problem?

Your arguments leave out the effect of reduction in global demand for U.S. goods and services for most of the U.S. economy.

How long can the U.S. Federal Government keep borrowing to finance it spending before the interest rate on Federal debt makes borrowing really unattractive?

If U.S. Federal government expenditures is a significant part of the GDP, our businesses appear to be in trouble as far as contributing to GDP.

My experience is that basing a conclusion about economic functioning on one factor is usually folly.

That is a ridiculous argument. Our percent of government spending to GDP is not nearly as high as other developed countries who had been experiencing strong growth as well before the recession. Yes GDP is calculated with government spending, because it is SPENDING. Kent Crawford clearly has it out for anything government, and isn’t willing accept that the private sector was the one who over leveraged itself by more than 100%, so who is the irresponsible one when it comes to spending? Also the government can simply make use of the excess capacity we have from all the unused capital that is just sitting there. Why do you think rates plunged during the crash? Capital fled out and into savings(T-bills etc.) It is a horrible sin for the government to NOT make use of that free money. For Kent Crawford to say anything different is insane and delusional.